Economists Question if QE Can Be Unwound

Econintersect:  Two economists posted an essay last week at the Triple Crisis blog.  The title of the piece written by Malcolm Sawyer (University of Leeds)  and Philip Arestis (University of Cambridge and University of the Basque Country, Spain) was “Quantitative Easing:  Can It Be Unwound?”  The two have doubts, discussed below.

Sawyer and Arestis describe the mechanics of QE (quantitative easing) in the UK from 2009 through the first months of 2013.  They point out that QE has had benefits:

• The borrowing needs and net debt of the government is reduced.

• The interest paid by the government on the debt purchased by a subsidairy of the Bank of England (after expenses) is returned to the government treasury.

• Central banks and governments have so far profited from QE as the central bank purchases interest bearing assets for money (which pays no interest).

The process described for the UK – Bank of England (BoE) arrangement seems much the same as the U.S. – Federal Reserve process.

Sawyer and Arestis explore two fundamental theses.

1. What happens when the flow of assets is reversed?

That is, when the gilts (or any other asset) is sold by the central bank to “unwind” the QE, how much money will the government receive in return?  If QE is reversed in a time of rising interest rates (generally expected to be the case) how much money will the BoE receive upon sale?  Likely less than they originally created.

Thus the Bank of England will experience a capital loss.  The authors refer to an indemnity provided by the government to the BoE for the asset purchases.  Presumably the BoE will suffer no losses; they will accrue to the government Treasury.  These will of course be offset (most likely only partially) by interest received during the QE holding period.

The losses realized will create a unique situation.  Sawyer and Arestis do not explicitly discuss this but they may have considered it (see the second thesis).  The government will have a “loss” because they will have created (via the BoE) one amount of money and have recovered a lesser amount upon resale of the gilts (or other assets).  The difference is money that remains in the economy and was not created through any corresponding debt asset.

Econintersect believes the process has created debt free money in the private sector.  At the same time the private sector has seen a change in asset values corresponding to the decline in prices during the unwinding.  So there is no net change in an accounting sense.  However, the value of interest paying securities has gone down but the amount of money in excess of market value of the securities has gone up.

Example: If the QE involved the payment of $1 for a security and the unwinding buys it back for $0.90 (after correction for time-value), the private sector has gone from owning the security only to owning the security and $0.10 cash as well.  That is $0.10 of debt free money, just as surely as if the government had minted an extra dime and given it to the private sector.

2.  Has the role of the BoE as purveyor of an independent monetary policy ended?

Sawyer and Arestis state it this way:

The conclusion is, then, that the Treasury, not the BoE, undertakes QE of its own. It would appear that the dividing line between the BoE ‘independent monetary policy’ and the Treasury’s budget plans is becoming rather obscure. Does this mean the beginning of the end of the notion of ‘independent monetary policy’?

The conclusion of Sawyer and Arestis is that there are risks to the stability of the financial system.  They fear a price may be paid for the “success” of QE in supporting asset prices without great success in the promotion of economic recovery.  Their concluding statement:

As the QE programme unwinds it is likely to involve the central bank and government in substantial losses, and to have consequences for the stability of the financial system.

Econintersect wonders what the risk is?  Is it the risk that asset prices will collapse? Or is it the risk that the “liberation” of the debt free money can create CPI and commodity inflation?

Why won’t the two effects be offsetting in a stabilizing way, much the way a sector rotation occurs in financial markets?

This discussion would seem all to calm for Max Kaiser who discussed the Sawyer-Arestis article with Stacy Herbert last week.  See video below:

[video:youtube:5fDSOiaAHQ0]

John Lounsbury

Hat tip to Dan Flemming.

Sources:

• Quantitative Easing:  Can It Be Unwound? (Malcolm Sawyer and Philip Arestis, Triple Crisis, 15 July 2013)

• Kaiser Report, Episode 472 (RT, 17 July 2013)